The Financial Crisis Inquiry Commission (FCIC) report described one
of three epidemics of accounting control fraud that drove the financial
crisis in these terms.

"Some real estate appraisers had also been expressing
concerns for years. From 2000 to 2007, a coalition of appraisal
organizations circulated and ultimately delivered to Washington
officials a public petition; signed by 11,000 appraisers and including
the name and address of each, it charged that lenders were pressuring
appraisers to place artificially high prices on properties. According to
the petition, lenders were 'blacklisting honest appraisers' and instead
assigning business only to appraisers who would hit the desired price
targets" [FCIC 2011: 18].

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The FCIC Report then documents scale of this epidemic of loan origination fraud.

"One 2003 survey found that 55% of the appraisers had
felt pressed to inflate the value of homes; by 2006, this had climbed to
90%. The pressure came most frequently from the mortgage brokers, but
appraisers reported it from real estate agents, lenders, and in many
cases borrowers themselves. Most often, refusal to raise the appraisal
meant losing the client" [FCIC 2011: 91].

A clarification is in order. The "client" was rarely the buyer
because, for obvious reasons, we do not allow the borrower to select the
appraiser. Even moderately-sized lenders have vastly greater power to
successfully extort appraisers than does any residential borrower. It
may be true that "many" borrowers tried to "pressure" appraisers to
increase the appraisal, but the overwhelming source of such pressure was
from lenders and their agents and virtually all of the successful pressure came from lenders and their agents.

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Then New York State Attorney General Andrew Cuomo's investigation
confirmed that the largest mortgage lenders were leading the extortion
of the appraisers to inflate appraised values.

"[I]n 2007the New York State attorney general sued First
American: relying on internal company documents, the complaint alleged
the corporation improperly let Washington Mutual's loan production staff
'hand-pick appraisers who bring in appraisal values high enough to
permit WaMu's loans to close, and improperly permit WaMu to pressure ".
appraisers to change appraisal values that are too low to permit loans
to close'" [FCIC 2011: 92].

These three findings allow us to understand a great deal about the appraisal fraud epidemic.

Appraisal fraud was endemic

Appraisal fraud was led by the controlling officers of lenders and their agents

No honest lender would ever coerce, or permit, the inflation of the
appraised value because the home's true value provides a critical
protection to the lender

The lenders' controlling officers were deliberately creating a
"Gresham's" dynamic in which bad ethics drives good ethics out of the
appraisal profession

In the late 1980s and early 1990s I trained regulators, special
agents (FBI, IRS CID, and Secret Service), state prosecutors, and AUSAs
these same implications of appraisal fraud and testified about those
implications before Congress and in criminal trials. Regulators, law
enforcement personnel, jurors, and even members of Congress readily
understood the implications I just set out. Jurors typically "got it"
within 15 seconds. The WSJ, writing about the third epidemic of appraisal fraud in 30 years, still doesn't "get it."

We now have well documented experience with two epidemics of
appraisal fraud -- the savings and loan debacle and the current crisis
plus the developing epidemic. It should be very hard to get appraisal
fraud wrong given these painful experiences and the appraisers'
astounding petition that made it inescapably clear no later than the
year 2000 that there was an epidemic of appraisal fraud led by the
lenders' controlling officers. Unfortunately, the Wall Street Journal is up to the task of getting it horrendously wrong.

Stop Me If You've Heard This Before: The WSJ Blames the Fraud Mice

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The WSJ's title for its article
on appraisal fraud makes obvious that it has learned nothing from two
fraud epidemics in two crises a quarter-century apart. "Dodgy Home
Appraisals are Making a Comeback: Industry Executives See Parallels With
Pre-Crisis Valuations, Regulators are Wary." Every aspect of the title
is disingenuous. The bank "executives see parallels" because they have
run the same appraisal fraud scheme twice only a few years apart. That
is one of the immense social costs of failing to prosecute the banksters
that led the fraud epidemics that drove the financial crisis. "Dodgy"
is a misleading euphemism for "fraud." The article uses the word "fraud"
only once. Even then, it uses the word "fraud" only to describe civil
investigations of appraisal fraud by Freddie Mac.

The WSJ's key sources for the article -- "Industry Executives" -- are the "perps" leading the frauds. The WSJ
article, however, never even considers the possibility that they are
(again) leading the effort to extort appraisers to inflate the appraised
value. The analytics-free nature of the WSJ article's analysis
is exemplified by this passage, which purports to explain the impact of
decreasing home sales and a declining rate of home price appreciation.

"That has put increasing pressure on loan officers, who
depend on originating new mortgages for their income, as well as
real-estate agents, who live on sales commissions. That in turn is
raising the heat on appraisers, whose valuations can make or break a
sale."

The obvious question, except to the WSJ, is why the banks'
controlling officers continue to design perverse compensation systems
for loan officers. The loan officers don't design their own compensation
systems. Everyone saw in the most recent crisis that the compensation
systems designed and implemented by the banks' controlling officers were
exceptionally criminogenic and had the inevitable effect of creating
the three fraud epidemics that drove the financial crisis. We have known
for over a century that if you pay loan officers on the basis of loan
origination volume you will produce endemic fraud. No bank CEO can claim
with a straight face to be "shocked, shocked" that when he creates
perverse compensation incentives the result is endemic fraud.

William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)